Confidence abounds: Link Asset Services turns spotlight on the UK CRE lending market 2018

By Paul Norman - Monday, March 12, 2018 9:30

Confidence is high among UK commercial real estate lenders at the start of 2018 with loan volumes and team sizes all set to grow, according to Link Asset Services’ (formerly Capita Asset Services) second annual Market Trend Analysis report, a major overview of the UK's real estate lending market taking in leverage, pricing and relative value among other key indicators.

CoStar News teamed up with Link last year to launch and report on the survey and its findings which aims to provide a regular analysis of and overview of UK real estate lending, with a series of questions on trends, the type of lenders operating in the market, and future expectations.

The report can be found here.

Key findings of the report are:

  • Confidence abounds at the start of 2018 with a significant majority of respondents expecting loan volumes and team sizes to grow.
  • Lenders have converged on leverage offered for investment loans but show far greater sensitivity to risk for development loans.
  • Pricing has only increased in the higher risk categories of debt; mezzanine, preferred equity and bridging finance; but has done so considerably.
  • The supply of long term debt continues to grow. With many expecting rates to rise, locking in low fixed rates of interest now may be a shrewd move.
  • Lenders’ preference has shifted into industrial/ logistics assets and hotels and away from the residential and retail sectors.
  • Property values in the residential market are considered to be more at risk than those in the commercial sectors.

In terms of market sentiment Link finds that as a whole there has been little change from a year ago in respect of team size and origination intentions.

In part Link says this reflects an uncannily similar backdrop with the UK market having seen a pick-up in commercial real estate transactional volume following the General Election result, similar to the recovery underway when last year’s data was collected, following the EU referendum result the previous summer.

“Lenders have learned to live with political uncertainty” say James Wright, Head of Real Estate Finance at Link. “They are seeking to do more business but lending has been adapted to the environment we are in. We’ve seen this take the form of an increased focus on lower-risk senior investment lending. Risker forms of debt are being priced at an increased premium.”

72% of lenders predict greater loan origination volumes in the next 12 months than the last, while 53% are seeking to increase origination headcount.

Respondents report that deals are taking longer to complete with it taking, on average, just under two months (53 days) to take out a commercial real estate loan in the UK, from agreeing terms to drawdown of funds - an increase from 46 days in 2017.

Interest rate consensus

There is a very clear consensus among respondents that we will see another rise in both the UK Base Rate (71%) and UK Treasury Gilts (65%) in the year ahead, with market expectations supporting this assertion and implying an increase in the UK Base Rate to just over 1%.

Lenders are still, by and large, expecting LTVs to remain stable on new loans but those respondents forecasting an increase has risen from one in 20 to almost one in 10 this time around. Pricing on new loans is also largely expected to remain stable, but nearly one in five predicts a pricing increase in the next 12 months.

Respondents say residential property values are at significantly more risk of value declines in the next year than commercial property. Link suggests this corroborates some of the thinking around BTL tax and regulatory changes driving smaller local UK investors into commercial property.

When asked what the biggest risk for commercial property markets is, 70% of respondents highlighted some form of political risk.

Brexit (40%), a change in government and general political uncertainty all featured. Other frequent responses included an interest rate rise and a drop in foreign investment volumes.

Leverage and pricing

For investment loans, the average maximum LTV available, across all debt types, has remained static but within individual lender categories there has been significant change. Last year’s data showed a standard deviation of over 9% which has dropped to less than 6% this year, demonstrating that lenders have converged on leverage.

Debt Funds are able to offer the highest overall leverage for investment loans at 83% LTV, jumping ahead of Hedge Funds this year who have taken a notable step down on investment LTVs.

Mezzanine leverage is generally topping out at around 85% LTV with just four respondents able to go beyond that. However, Preferred Equity funding is available from nine further respondents. For Bridge Loans, average maximum leverage is 70%.

Margin wise averages on the higher risk categories of debt have risen from last year, with only Senior Loans (-21 bps) now available at cheaper rates.

Mezzanine Loan costs have risen by a modest 45 bps but Bridge Loans (+223 bps) and Preferred Equity (+196 bps) are notably more expensive than a year ago.

Peer to Peer Lenders registered the largest increase in average margins but have dropped maximum leverage. Part of this can be attributed Link says “to more lenders in this category offering investment loans this year with many simply pricing those loans at a similar level to their development loans”.

Pfandbrief Banks are able to offer the lowest cost of senior debt with an average margin of 170 bps and an average arrangement fee of 82 bps. This is a reduction from 2017 (200 bps and 88 bps respectively).

Insurance Companies and Pension Funds are close, on average offering senior loans at or just over 200 bps margin, in line with their 2017 pricing.

UK banks feature as the cheapest source of Mezzanine and Bridging Loans. For Mezzanine Loans, they are closely followed by Pension Funds, who did not offer this type of debt in 2017. Middle Eastern Banks have been responsible for much of the pricing increase in Mezzanine Loans (1100 bps margin in 2018 versus 917 bps in 2017) and Bridge Loans (1800 bps versus 1100 bps a year ago).

For investment Whole Loans, the European Banks, Pension Funds and North American Banks offer the best rates.

Relative value

A particularly helpful feature of Link’s data set is its 'relative value' measurements where Link compares average data within each lender category to assess their ‘relative value’ based on maximum leverage offered against average margin pricing.

There are two significant changes from 2017 for senior investment loans. Firstly the trend line is significantly flatter, reflecting the considerable convergence on leverage. Secondly, where it saw three fairly distinct lender groups last year, in 2018 Hedge Funds have reduced margins to join the lender group between 475 and 625 bps, leaving Peer to Peer Lenders as a sole outlier at an average of 950 bps.

Lending on ‘prime’ transactions (priced at less than 350 bps margin) is by far the most competitive segment of the market with eight of the 12 lender categories competing in this space. Debt funds represent the best ‘relative value’ for senior investment loans.

Compared to last year income covenant requirements have been relaxed.

Development loan wise Despite a slight reduction in their leverage from last year, Peer to Peer Lenders offer the highest LTC in the market (87%). Link points out that at 69% their LTGDV is bettered by Hedge Funds and Debt Funds, which indicates that they cannot offer the highest leverage except for the most profitable schemes. Hedge Funds and Debt Funds, at 71%, offer the joint highest maximum LTGDV on average.

Sector and availability

All locations in the UK increased in popularity with two exceptions. The first is London, which has remained the most popular region but has been caught up by most of the UK’s other regions. The second is Scotland which has declined in attractiveness to lenders. Northern Ireland is the least favoured region and the only one in which more than half of respondents will not do business.

When it comes to real estate sectors, lenders are increasingly specific with their capital deployment, highlighting six sectors on average they will lend in compared to seven in 2017.

The most significant changes in lenders’ preference is a strong shift away from the residential and retail sectors and into industrial/logistics assets and hotels. Office remains the most sought after asset class for investment loans and is now just 7% behind residential in development preference (16% lower in 2017). Healthcare and leisure sectors, which were added to the survey options this year, are the least popular asset types.

Ticket sizes

Link says very large ticket sizes should be easier to fund this year with an increase in the number of lenders able to lend £500m or more on investment loans (8 up from 5) and £250m or more on development deals (7 up from 3).

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